1. Principles of Investing FIN 330
Chapter 13
Fundamental Analysis II
Financial Statement Analysis
Dr. David P Echevarria
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2. Review of Financial Statements
Balance Sheet
Snapshot of company’s assets, Liabilities and Equity at end of fiscal year. Calculate Working Capital.
Income statement
Sales, expenses, and taxes incurred to operate –profit margins
Earnings per share: Net Income / # Shares Out.
Cash flow statement
Sources and uses of funds
Are financial statements reliable?
G.A.A.P. vs Cleverly Rigged Accounting Ploys
Principal motive for Sarbanes-Oxley (2002)
Dr. David P Echevarria
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3. Financial Statement Analysis (FSA)
In this chapter, you will learn how to further analyze a firm’s financial statements using ratios.
By calculating financial ratios, you are able to directly compare a firm’s performance with the results of other firms as well as it’s historic trends.
Dr. David P Echevarria
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4. Sources of Information
Financial Statement Data
Quarterly, Annual Reports issued by companies to stockholders
Computerized Data Bases such as [WRDS] Compustat
Standard & Poor' Industrial Manuals, Moody's
EDGAR database at the SEC (
Industry Averages
Robert Morris Associates
Dun & Bradstreet
Federal Agencies;
Commerce Department
Federal Reserve
Dr. David P Echevarria
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5. Ratio Categories Liquidity ratios
Measure ability to pay maturing obligations
Current ratio
Current assets / current liabilities
Quick ratio*
Current assets less inventories / current liabilities
Cash ratio
(Cash + M/S)  current liabilities
Defensive Interval
= [(Cash + M/S + A/R) * 365 ]  (COGS + SGA).
Dr. David P Echevarria
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6. Ratio Categories B. Asset Management [Activity] ratios
Measure effectiveness of asset management
Days Sales Outstanding (DSO)
Average receivables / Sales per day
Inventory turnover (times per year)
Cost of Goods Sold / average inventory
Total asset turnover
Sales / average total assets
Fixed asset turnover
Sales / average net fixed assets
Dr. David P Echevarria
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7. Ratio Categories C. Debt Management [Leverage] ratios
Measure extent to which firm uses debt to finance asset investment (risk attribute)
Debt-equity ratio
Total long-term debt / total equity
Total debt to total assets ratio (Debt Ratio)
Current liabilities + long-term debt / total assets
Times interest earned
EBIT / interest charges
Fixed charge coverage ratio
(EBIT + Lease Exp.) / (Int. Exp. + Lease Exp.)
Dr. David P Echevarria
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8. Ratio Categories D. Profitability ratios Gross profit margin (%)
Gross profit / sales
Operating Profit Margin (%)
Operating profits / sales
(Sales - COGS - operating expenses) / sales
Net profit margin (%)
Net profit after taxes / sales
Return on total capital (%)
Net income + interest expense / Total long-term capital
Return on stockholders’ equity (ROE) (%)
Net income after taxes / common stock equity
Dr. David P Echevarria
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9. Ratio Categories Valuation Ratios Price / Earnings: Price / EPS
Book Value: Total Assets –Total Liabilities
TA – TL = [Total Common] Equity
Book Value Per Share = BV / # Shares Out.
Earnings per Share = Net Income / # Shares Out
Dr. David P Echevarria
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10. DuPont System ROE = ROA * Equity Kicker Objective of DuPont System
ROA = Net Income / Total Assets
Equity Kicker = Total Assets / Common Equity
Objective of DuPont System
Assist management in identifying areas where performance can be improved. It also helps to understand the impact of changes in the debt ratio on ROE – which in turn affects stock price.
Dr. David P Echevarria
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11. Management Functions Planning - setting goals/resources
Organizing - assigning tasks/resources
Leading - motivating achievement
Controlling - monitoring performance
Dr. David P Echevarria
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12. Evaluating Management Quality
Age and experience of management
Strategic planning
Understanding of the global environment
Adaptability to external changes
Marketing strategy
Track record of the competitive position
Public image
Finance Strategy - adequate and appropriate
Employee/union relations
Effectiveness of board of directors
Dr. David P Echevarria
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13. Estimating Earnings and Fair Market Value for Equity
Five Steps
Estimate next year’s sales revenues
Estimate next year’s expenses
Earnings = Revenue - Expenses
Estimate next year’s dividend per share
= Earnings Per Share * dividend payout ratio
Estimate the fair market value of stock given next years earnings, dividend, ROE, and growth rate for dividends Using Gordon Growth model or P/E Model
Implications for investors
Fundamental analysis assumes company performance and stock performance are correlated
Forecasting EPS and P/E helps predict expected returns
Dr. David P Echevarria
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14. Homework
Key Terms: Economic v-v Accounting Earnings. Liquidity Ratios, Debt Ratios, Asset Management Ratios, Profitability Ratios; what do the ratios measure in general?
True/False: 1, 2, 3, 5, 8, 12, 15
Practice Problems: 1 – 9
Dr. David P Echevarria
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